Tuesday, December 22, 2009

'Tis the Season of Hope

On December 4th, Investophoria wrote '... we have returned to the "olden days" of the bubble era'.  This was demonstrated by quantifiable measurements of investor complacency.  We also noted that this market is literally on less footing than in '07.

That footing has gotten even more slippery, the bullish gas powering this motor reduced to near fumes.  Since December 4th, when we last posted an update on our market thoughts, the market has done this:


Despite the fact the Hope mentality grows stronger and stronger, as indicated by the further increase in bullish extreme in the next charts, the market is virtually sideways.

We are, however, anticipating a further incline throughout holiday trading on very light volume that should take the Dow up about 250 - 300 points from its current levels before the long-term reversal and downtrend resumes.

This bear market has at least one major downward leg in it as deflationary pressures continue to mount and all inflationary attempts by government are either utter failures or completely counterproductive.

Here are the Investor Intelligence Surveys for the most recent period.



 

We are at even higher extremes in optimism and bullishness in stocks will almost nothing to show for it.  Again, this is indicative of an imminent top in the major indices, which should follow the risk currencies and commodities downward.  Gold and silver have already resumed their bear-market trends and the primary direction for these metals is down.  The majority of commodities should follow suit as virtually all markets except the USD decline in near tandem.

As more debt defaults are called in, the demand for USD's - which make up a huge majority of all debt in the world - will continuously grow, fueling even further increases in its value due to the actual scarcity of cash reserves relative to debt, which is currently treated as cash in most markets.

If you haven't already, our recommendation stands firm - treat yourself to another gift this Christmas Season and be thankful for an excellent exit opportunity for your stocks, muni and corporate bond holdings, and commodity holdings.  As we have stated many times before, in this Deflationary Depression, "Cash is King, and will soon be Emperor".

Enjoy the holiday season all, and be thankful for those around you!

Derek.

Friday, December 4, 2009

An Old-Time Rerun - This Market's On Less Footing Than '07

It seems that we have returned to the "olden days" of the bubble era.  In fact, the words bubble, gold, bull market, and stocks seem to be popping up on finance web sites all over the virtual stratosphere.

To make things worse, on-the-street retail investors and those that represent them (hedge fund and mutual fund managers as indicated by equities vs cash holdings - averaging about 4% cash currently!) appear to be eating it up.  And we are at the point where we have discarded cutlery for the more subtle by-the-fistful type of gorging.  Where everyone is out to make up the severe beating their portfolios took last year.

As demonstrated in the following charts, we have seen by far the worst level of complacency since this bear market started.  This is highly indicative of a major turning point in equities price-movement and prime territory for a long-term shift in investor psychology and mood that will bring on the largest portion of this bear market.  We anticipate an imminent turn in equities within weeks (if not days) which will herald the sharpest and deepest declines in their perceived values.



The ratio of bears to bulls is almost at its highest point on the chart and is sporting the same near-vertical price movement that it did as the market topped out in late 2007.  From the market bottom, this ratio has gone up over 150% in quantitative terms indicating a massive shift in investor psychology.  Since this positive sentiment is based on nothing more than "hope" at this point in the game, it may (and likely will) reverse just as swiftly as it ascended and should make a new low on the Investor Intelligence ratio.


 
 
To further demonstrate the "hope" mentality that permeates current market psychology, the percentage of bears surveyed is at its lowest point in a decade.  This indicates both a complacency towards danger (for example, junk bond spreads have narrowed by over 50% relative to treasuries in the past 10 months while defaults are at their highest since the 1930's) , and a clinging to hope and extreme optimism.

Finally, we reiterate our advice.  Liquidate stocks and corporate, territorial, and municipal bond holdings and conserve cash by either holding actual dollars or their safest short-term equivalents.

Have a wonderful weekend!

Derek.

Thursday, November 26, 2009

Speculation, Denial, and Gold's Parabolic Rise (and Fall?)

Last article I covered the philosophy of gold and why that itself must change in the mind of the general public before we can see a real bull market.  The arguments are here, and though the angry gold-bug letters calling for $10,000 / oz gold in 6 months continue to pour in, I have also received a few "hmmm, I never looked at this gold bull market like that before" emails which puts a smile on my face.

After all, at Investophoria we aren't just into helping ourselves, but educating would-be and professional investors alike with the "other side of the trade".

And so, this brings us to today's topic.  Denial and speculation.

I subscribe to several precious metals newsletters, some weekly and some monthly.  For me, they are not so much a means of getting precious metals advice, as they are to see what the mind of the avid gold investor is surmising at any given point in the market cycle.

The last several letters that I have received have given me pause - each from a different type of investor (one in speculative juniors and mid-cap producers, one in futures, one physical-only) they have all touched on the idea of speculation in gold and - in their own way - tried to debunk such a claim.

But the same type of arguments used to discount any idea of speculation in gold are very similar to the types of arguments tried to discount speculation in any other market.  They are also willing to believe that while speculation in Asset A over here is certainly a bubble (stocks, junk bonds, munis, commercial property - take your pick), speculation in Asset B over here (gold, gold stocks, gold etfs, etc) is most certainly NOT a bubble.

This is of course funny considering the money for both types of speculation generally comes from the same or very similar sources.  In fact, even in the simplest of picture terms we can see that paper speculation and NOT a philosophical shift towards gold is occurring. 


The parabola can be seen in any bubble in investor psychology going all the way back to the late 1600's Amsterdam Tulip Bulb Craze right up until today.  Most of my readers are familiar with these bubble-chart-formations so I will not dwell on them long.

My question is, however, for gold bugs - why is it that when we see this picture on any other asset it is called a "bubble", and yet when it is in precious metals it is "as it should be"?

I mentioned that similar price action in real estate occurred in the previous recession compared to gold in this one.  The mass-migration of money into real estate, and the subsequent bubble in real estate prices certainly felt good to someone.

These "someones" I will call Real-Estate-Bugs - those people who all your life said "real estate is the best investment" and "you can't lose with a house" long long long before everyone and their uncle was saying these things in the mid-2000's.  Those guys could walk around with puffed out chests and smiles of good-old-fashioned pride at the proof of their intelligence.

Until things got a little out of hand.

Right now these long-term gold bugs who bought and held at $850 in the 1980's (and are still down over $1000 inflation adjusted dollars) are starting to feel some vindication.  All those things they said are coming true!  They are finally proven right, after so many long long years.  And while the psychology in gold is obviously not even close to the extremes in real estate (we are much earlier in the gold bull-market than real estate in the 2000s), it is still there nonetheless.

This is not the real bull market in gold, folks.  The majority of money pumping into gold is going in for investment purposes, not for savings purposesThese people are expecting to MAKE money, not HAVE money, and until this mentality towards gold is shaken and the speculators scurry off to lick their wounds and throw their chips on another table, this bull market is not real

There is one thing I make very clear to my clients right off the hop.  There is a very specific criteria for investing that only a few investors actually take into account (to their peril).  Most investors think that buying an asset is investing - anything that is not cash is an "investment" if you expect it to go up in value.

In my mind that is entirely false, and is indicative of the times in which we live in terms of the long term (100 years or so) cycle in investor psychology, social progress, and attitudes towards money.

What is an investment, then?  I have said this many times before and I will say it again - An investment is an asset whose primary goal is to generate an income from the expended capital used to acquire it.  A yield.  Cashflow.

What good is "investing" if the only return you hope to get is that someone down the line is will to pay more for what you paid today?  Certainly, I take a valuation approach to buying assets, but the motivation is not to simply buy something on the cheap for the fact it is cheap - the main reason for this is because if the asset is undervalued, the yield is undervalued as well.  If XYZ Inc.'s stock drops 50% with the market but their earnings and payout stay the same, the yield has gone up 100%.

No, dear readers, gold is not an investment.  We have covered this before as well - it is a non-yielding asset.  To me, when someone says they are investing in gold, it is the same as saying they are "investing" in a house.  A house is a non-yielding asset unless you rent it out.  So many bought 2 and 3 homes with the hope that somewhere down the line, someone would be willing to pay more for them.  That is not investing, that is speculation.  If these homes were purchased for the purpose of renting them and generating an income, and the capital appreciation was secondary, THAT is investing - most of the homes built and bought since 2003 were certainly not purchased for income!

As such this money pouring into gold is currently speculative.  Very little of it is for the true purpose of gold, which is to have money itselfWhen a hedge fund buys gold, do you think it is because they are interested in owning real money and tangible savings?  Of course not!  They are buying it because it was the only asset to not get completely clobbered when the rest of their holdings were getting torched.  They are buying because their investors are demanding it!

So what am I saying?  That gold is in a huge bubble?  Absolutely not - the amount of money that has entered the gold market is tiny compared to the other speculative assets.  However, gold is not supposed to be a speculative asset - it is money. 

What we at Investophoria are saying is that gold will resume the largest part of its bull-market within the next few years.  However, this bull market will occur once again when gold is out-of-favor with most investors and quietly increase in value as people continue to use it as a savings vehicle.  Thankfully, unlike an un-yielding house, it also costs little to nothing to keep gold which will encourage its use for savings over most existing assets.

But first the correction must come - the other side of the parabola, where these hedge funds and profit chasers who are usually the last to the party get shaken off the gold-train.  Make no mistake, folks - once this correction has occurred we are buyers of gold - and more importantly, silver - en masse, and the bulk of our cash savings will be converted into metals savings.

Until that time, in the very least, try to recognize these price movements as patters of psychology - which, in the end, is all that determines the price of any asset.  Use this as an objective picture to see what the mentality behind gold really is - after all, we can argue arbitrary points like over-the-counter botique gold bar sales and the fact that I find at least one article on gold on almost every mainstream investment site I visit until we are blue in the face.  Price is not subjectively inclined to one side or the other - it is what it is.  And we can use that to find out not only "what it is" but "where it is headed".


Gold's day is coming soon enough, but that day is most certainly not yet.

Best of luck!

Derek.

P.S. In case you don't remember, we made a prediction back on September 14 of the top of this rally hitting 1,132 on the S&P500, and offered a fairly compelling chart to illustrate.  We are within inches of this market topping point, and suggest moving entirely to cash if you haven't already - or, if you are so inclined, to a fully-short position.  Also, check out some of the other predictions in this article and see how we've stacked up!


Thursday, November 5, 2009

Gold's Last Gasp?

Although we haven't added to our gold position in some months at Investophoria, it's still fun to watch.

Gold Bugs are one-of-a-kind type people.  When they are right, they are right.  When they are wrong, they will be right.  And here's the funny thing.  Although most of the outside investing world goes through periods of scoffing (think late 1990's to early 2000's), to periods where telling someone "gold is going down" gets you looked at like you are some amorphous blob of alien goo that ejected itself from a UFO exhaust, they hold true to their gold-buggery through the high times and the low times.  Gold bugs are one of the rare breed of individual who never lets go.

However, a true bug is even rarer than an "average" gold bug - the actual ranks of gold buggery swell and subside, like the tide of a sunset ocean.  The true gold bug does not care so much about the price of gold as the idea of gold itself.

Gold truly is a remarkable metal.  It is the singular item that above all others has been naturally chosen by the markets to facilitate trade and store value.

Gold bugs understand this, and wait for the day that the wide-spread use of this universal medium returns.  The days where the philosophy of gold and the true economic freedom of gold are recognized by the majority, instead of a small minority.

What is this freedom?  What is this philosophy?  Why the heck do gold bugs get so damned buggish about the yellow metal?

In order to capture the truth of gold, I would need weeks of writing to list its virtues and strengths.  However I do not have weeks to write this article just as you don't have weeks to read it.  So I'll instead refer you to the folks who have paved the way.  Here's a good place for you to start:

Human Action by Ludwig Von Mises -  You can Read it Here for Free!

Gold and Economic Freedom - By Alan Greenspan, before "the fall".

Right now, gold bugs true and "en-vogue" are loudly proclaiming victory as gold has YET AGAIN made a new record high.  At long last they are vindicated!  At long last all those who scoffed at them since the early 1980's are proven wrong!

But the point of the matter is that gold bugs have in fact NOT been proven right, and the scoffers are probably going to get one last chance to scoff.

At least, Not Yet.

Do you remember the post-dot-com-bubble recession?  Hardly, I know - it was merely a blip a notch between two giant waves of economic growth.  Few people remember why the activities of government and Federal Reserve alike were so dangerous, and one of the specific reasons that we saw the greatest credit fueled housing bubble in the history of recorded mankind.

So, why did every average person, every newscaster, every mainstream investment adviser all stampede toward real estate like a a herd of antelope running from a pride of ravenous lions?

It's pretty simple.  So much easy money was injected, such a tidal wave of cheap dollar credit was flooded into the economy at the first signs of recession, that housing starts did not go down at all during the recession.

In fact, they increased.

The significance of this was immense.  This was the first recorded recession in American history where housing starts did not decline.  The first time that house prices didn't suffer.

Never mind the cause, the disease, people looked at the symptoms - the result.  They forgot all past recessions and focused on this singular and momentous even in economic history.  The soon-to-be-mantra, chanted by one and all and a contrarian's ultimate red-flag bubble-warning:  Houses don't go down in value.  They are recession proof.  They are an investment.  You can't lose money in real estate.

And so on

Here we are today.  Even without knowing what I know about price movements, about bubbles, about unwinding long-term false price-signals, the contrarian in me tells me there is some time to go.  Even without knowing that whenever a massive psychological bubble is created, so much malinvestment exists in that bubble that the end result is a LOWER measure of success (price) than before the bubble was created.

Because everyone out there is still calling for "a bottom in real estate."  They have been calling for it since the first "correction" in prices.  Real estate is some ways off from being cheap, folks.  The time to buy a house is when everyone complains that money cannot be made in real estate, and that you are crazy and will lose your shirt if you invest in it.  We are far from that point.  We need the philosophy of real estate to change.

Which brings me back to gold - why gold bugs are going to have to wait some time longer to feel vindicated and victorious.  To feel that the stripes they earned slowly accumulating their real wealth have paid off.

The philosophy of gold is not mainstream.  The fact that it was the best-performing "asset" during the stock market crash, the real estate crash, the bond market crash, the commodity crash, all of it.  The same situation that occurred with real estate in 2002 has occurred with gold.  People don't buy it as money, they don't save and store wealth with it, they are seeking capital gains.

And when the majority is seeking capital gains (just look at paper-holding ETF inflows and Commitment of Traders reports for gold investment to verify what I'm talking about here), not-to-far-away comes the point where they lose.  The nominal value of their investments decline.

Gold just smashed through a record with a breathtaking rally.  It's holding up at $1090.00 as I write this.  Gold bugs are celebrating again.

But they should remember.  When they were buying gold, it was contrarian.  In 2002, at $250 an ounce, when the last Wall Street analyst simply gave up on covering gold, saying "there is nothing good about gold", that was the time to buy.

But now the "never-go-down" psychology of mainstream investors has permeated into gold.  Buying gold is so in right now, that even high-end retailers are selling bars out of their storefronts.  To the contrarian in me, this signals an imminent top.  This is the stage where "hope" has taken over in the place of "worry", which is where real rally build.  I would be remiss to pick an absolute top, but in reading the daily COT report, the maximum extension of gold buyers vs. sellers that has been the theme of the last 4 weeks seems over-extended at best.



Gold's young cousin, silver, has still failed to make a new high with gold.  Far from it.  If this were a true new high, silver should be somewhere about $23-$25 per ounce.  However it is far from it, having failed to even breach the $18 mark today.




Gold is going to suffer a serious correction in dollar terms.  Greater than the one that occurred last fall, as this positive sentiment must be wound out.  Dare I call these new highs in gold "malinvestment" as I would real estate?  I certainly will, though even I cringe as I type the word.  Malinvestment has to do with expectation and intent - those buying gold now have the same expectations of gold they did of real estate in 2006, that it will continue to go up.

But the philosophy has not changed.  No, dear readers, the REAL future move in gold will be one where the everyman and every-woman is awakened to its virtues.  The speculators will have moved on to some other asset class, some other investment.  They will be too "worried" about gold's price to bother trying a second go.  This is where gold will finally see its real glory and climb the long and arduous "wall of worry".  Once the philosophy changes, so shall vindication of gold-bugs be realized.  Gold will quietly cross the $1100, $1200, $1300 and so-on mark while the very few are watching.

Real bull markets do not occur in the spotlight.  Tops do.  And bottoms.

The US dollar is possibly the most hated piece of paper in investor terms on earth today (leaving aside notable exceptions such as Zimbabwe's dollar et al hyperinflationist currencies).  Gold is the most loved metal.  That is why we fly the contrarian flag today.  The deflationist flag. 

But we will be watching our dear metals.  I am no gold-bull, but a gold-bug.  And when gold really IS the best store of value you can bet the farm that I will be a buyer.  Today, though, it is not - too many speculators have sucked the value out of it.  Once they are gone my bull-flag will be back up, and up long-term.

Until then, stay the course and protect your hard-earned savings, dear readers.  The time to be bullish on the metals is not far at hand.  It is just not today.

Happy Investing All.

Derek.


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Sunday, November 1, 2009

Why We're Expecting November and December to Fly Like a Piano

Sometimes a little perspective can be had from poking around.  Weekend articles are excellent for financial news because very often big things happen on weekends in the hopes that it will be "old news" and have made way for something else by the time the open bell rings on Monday morning.

For example:

CIT Group Files for Ch 11 Bankruptcy (Finally)

Not that this is REALLY new news for anyone - their bond/equity deal was a last ditch effort with a low probability of success at best.  But who knows, maybe the 5th largest bankruptcy filing in US history by assets is the first of a renewed trend.

I've also been reading something pretty hilarious as I poked around the usual MS financial sites like Bloomburg, CNBC, the Globe and Mail, et al.

I see many mentions of historical performance - remember, coming into October, most mainstream market pundits were citing the fact that "October is historically a bad month for the market".  Now, on the other hand, the perspective has swung drastically.  "November and December historically provide superior gains" and such other nonsense is being put out there against the back drop that the market is suffering a "temporary correction".

Now, I'll cover this briefly - the contrarian in me is laughing out loud, thinking "we're in the biggest bear market in history, so why shouldn't October - historically a HORRIBLE month - turn out not-so-bad, and why shouldn't November-December proffer huge declines in the markets?"

Our forecast still holds tangible and strong.  A look at the long-term chart of the S&P gives us a perfect long-term channel correction in a continued bear market.  The target price for the index is below 200 points, which may sound outrageous now, but as time unfolds will most likely prove truer, sooner.

Hold on To your Hats, Folks!
We'll catch up later in the week with you, diligent readers.  If you are not in cash we hold our recommendation of making that move ASAP.  The more of it you have in your hand the better.

Cheers!

Derek.


Thursday, October 29, 2009

Mythbusting the USD and Future Interest Rates



 During these days of Dazing and Confusion, there are two polar-opposite arguments for the near and mid-term future of the US Dollar.

On the one hand:

Is This the Death of the Dollar?

Protecting Yourself Against the US Dollar Collapse

Is the Dollar Going Down Forever?


And the other:

Deleveraging Pushes the Dollar Up

And that's about all I could find by typing in "US dollar going up" in Google that is recent and credible.  Otherwise you'll find mostly Ask Yahoo! questions like "is the US Dollar going up or down?"

Which goes to illustrate a point that I have been trying to get across for some time, but is secondary for this particular article:  Almost everyone out there has bought into the "Death of the Dollar" scenario.  There are very very few left on my side of the trade.  (Which is why I'm there, remember?)

Tonight, however, I'm not going to focus on  the particular direction the US dollar is going, more on - hypothetically speaking - what both sides of the argument are saying will happen to the interest rates on loans.  Specifically I am going to focus on Treasury Bonds.

The Commonly Cited "Fact" - Interest Rates are determined at treasury bond auctions based on the risk of inflation or deflation. 

  • If the prospect for inflation is very high, treasury yields will rise up to a level where the market thinks the interest earned on the loan will beat the rate of inflation.
  • If deflation is expected, interest rates will be very low, as people are more concerned with simply keeping their cash safe as opposed to putting it into an asset that will be worth less in dollar terms.
This is the general arguments and banter that one will hear when reading mainstream financial news or commentary, listening to the usual economists discuss economic policy, and virtually any other place where Treasury rates are discussed.

Unfortunately this is a partially false assumption, as this aspect of interest rates is actually only a part of the real reason interest rates rise and fall. The usual argument for Treasury bond rates is a far cry from the truth.

I am going to explain to you why I expect BOTH rapid and violent deflation AND higher interest rates in the mid-term, guided specifically by treasury bond yields.

The Investophoria Argument:


The first factor we have to consider in bond interest rates is general supply and demand.  This is the oldest of economic principles and applies not only to potatoes and cars and oil, but to currencies as well.  By issuing a bond, the government is increasing demand for actual dollars, taking from the supply of existing dollars and trading them for a piece of paper that says they will repay them plus interest at a pre-designated future date.  While the Fed is monetizing a large portion of these, the foreign buyer market has still made up a significant portion of the Treasury purchasing crowd.  One of the largest ever, actually.

The second factor we have to look at is a result of the first factor.  As demand increases and supply contracts, the overall value of the dollar actually increases relative to the goods and services in the economy.  This is the result of deflation (shrinking amount of total money).  Bonds' interest rates are not only factoring in possible inflation (i.e. return ON money), but are - more importantly - factoring in the ability to repay the debt at all!  (Return OF money).


If the likelihood of principal repaying is very high, the interest rate will be low - buyers are willing to take a lower yield for the security of knowing their principal is going to be returned to them.

However, if there is a good chance that the borrower is going to default on the bond, then the interest rate is going to be higher - there has to be a higher reward for the higher risk.  Hence the fact that junk-bonds from corporations have far higher yields than AAA rated bonds do.

So here is our forecast - we see a high probability of both deflation AND high interest rates within the next 2-3 years (which most traditional analysts will tell you is not how things work - again, ringing the long-term contrarian bell here!)

How is this possible?

It's pretty simple when it comes down to it.  One-paragraph kind of simple: 

If the USD rapidly deflates, there will be far less US dollars the government can get (from taxes and such) to repay their bonds with, and thus the risk of default is far higher than during inflationary times when there is more dollars in existence every day.  Thus, even though the dollar is going UP in value and interest rates "should" be low, we expect the bond-market to experience the dawning realization that deflation is what could actually cause governments to default on their debt.  Thus, very high interest rates on Treasury bonds hand-in-hand with rapid deflation!


Our recommendation is as follows:

For the mid-term, cash and short-term treasury bills that can be rolled over easily and withdrawn easily are the optimal means of protecting wealth.  As I said in a recent seminar, "Cash is king, and will soon be proven Emperor".  For more aggressive investors selective shorts or LEAPS can make significant returns on top of the appreciation in the underlying USD.

However, once we see interest rates begin to hike back during the final decline in this market, we recommend switching entirely to cash and being ready to purchase stocks.

A note on gold:  We expect that the bottom of this correction in gold to under $700 will be hit long before this, and that gold will experience a quiet bull-market back up to roughly its current price level around $1,000 - $1,100 per ounce (much the same as its quiet rally from 2001 - 2006. 

Once the predicted scenario of rising rates AND a rising dollar unfolds, we expect the real legs of the future rally in precious metals to take off, as a slow trickle of people enter the market realizing that gold is the safest form of money. 


That is some food for though - a tidbit to keep in the corner of the mind until the "wall of worry" comes into play again.

Until then, I want you to remember something:

The psychology toward stocks at the market peak in 1929 was about as positive as it was toward credit:  Namely, that stocks always went up and that credit was the true fuel upon which the fires of the economy must feed.  Why, that's why there was such amazing growth!

The result of this "pro-paper, pro-credit" mind set was a huge bust. On top of the bust - because of the policies of the Federal Reserve and government, slowing down and dragging out the cleansing of the mailinvestments during the "roaring twenties" - what should have been a very sharp and deep (but short) recession with rapid deflation, turned into over a decade of misery.

The perspective toward stocks changed.  Nobody wanted them in 1933.  In fact, it took an entire generation (25 years) just to get back up to that same level in the markets that sentiment hit in 1929.  Remember that, and keep in mind that sentiment toward stocks from 2000 to 2007 was at an all time high period, as represented in percent of net worth, and in percent of GDP.

And finally, this:  "History never repeats itself, but it often rhymes."  Mark Twain

Enjoy your Thursday, Dear Readers!  I've had a ton of questions the past week and I'm sorry if I haven't gotten to them all, but it's been crazily busy - however, I promise I will try to respond within a couple of days from when you send them.

Be Safe out There,

Derek.



 

Wednesday, October 28, 2009

One Hell of a Market Cross-Roads

So here's the scoop.  A nice brief article.  No mention of gold (except to mention that I'm not mentioning it right here), or the USD.  I'll stay away from individual stocks and commodities today.

No, dear reader, my concern lies with something I brought to your (and my) attention back on September 14th.

Remember when I said that the most likely place the S&P500 would rally to was 1,132, according to a fibonacci retracement calculation that was further strengthened by that nice downward trend line dating right back to the all-time market top in October of 2007?

I present for you, the updated version:


As you can see here (by clicking the chart), the major downshift in sentiment has a nice trend-line dating all of the way back to the all-time market top.

This is the point where anyone still invested long in stocks should really consider pulling out the majority (if not all) of these holdings and sitting in cash to ride out the next leg of this long-term bear market.

Going short isn't such a bad idea either (and probably 3 or 4 times more profitable than cash), if you are the type - just make sure that your brokerage or trading firm isn't one of the weaker ones as many will be blown away by the sheer volume that is going to come into this decline.  Not to mention some might have a hard time, you know, existing with those awesome capital rations of theirs!

As always, stay safe out there.  The next leg down should break far below that lower trendline in the downward channel and we probably won't see a total low for the market for up to 12 months.  The lower part of the channel should act as overhead resistance for the trendline.

My suspicions, however, (and coincided with studying the market moves of the Great Depression and other market bubbles) is that we won't see that lower trendline for some time once we break through it.

Of course, the unthinkable could happen and we could have a mad dash to new heights first.  However, I'm just not seeing it as the DSI is hovering around 90% or more on practically every market that has be making new highs for weeks!  And the DSI is 93% bearish on the dollar for a MONTH.  Yikes.  Feels like sentiment is way too stretched.

Happy Investing.  Remember Mark Twain's sage advice for these times:

"I am more concerned with the return of my capital than the return on  my capital."  

Truly coined for the depression era.  Sock away every penny folks, save as much cash as you can and be ready for those once-a-century buying opportunities not-too-far down the road. 

Derek.

Sunday, October 25, 2009

A Shiny Bit of Perspective on the Metals That Gleam.

As the hate-mail has continued to pour into this writer's inbox, my position of selling out of the precious metal stocks that I purchased in late fall 2008 continues to be psychologically fortified.  After all, as I have said many times previously, I am as contrarian as I can be - the more hate mail I get (not that I'm a glutton for punishment or anything!), the more confident I am.

Loneliness, it seems, can be a wonderful thing at times.  In terms of finance it can be the best of things.

It is the state in which I find myself now - alone (or far enough between the few on my side that I might as well be) in my bearish calls on the precious metals.

I know that changing a gold bug's mind is about as likely as Mr. Obama having a personal free-market Renaissance, but I still feel it is my duty to try - the only wish I have at this point of the game is to save folks from making the mistake of trading something that is going to go UP in value for something that is going to go DOWN in valueThis is not the type of decision that makes the least bit of prudential sense, and yet, the number of those making it grows greater and greater daily.

But don't just take my word for it:

Gold Open Interest is far above the previous all-time high in March 2008.  the additional 50,000 open contracts is 500,000 ounces of gold, or  $525,000,000.00 of additional exposure to the gold market.  This is of course not including gold stocks, which have extremely low short ratios (the amount of shares short versus total shares available to trade).

A few examples, you say?  I though you'd never ask!

Barrick Gold - ABX - Despite having such crummy management of their hedge book (the $3.6 Billion in diluted new-share issues is most certainly not enough to cover the hedge book at this gold price), the short interest is at only 1.3%!  Meanwhile, 66,000 Call options contracts this month versus 31,000 Put Options should tell you the story - while the overall market is at 120% calls compared to puts, the most mismanaged major gold producer is at 213% calls to puts.  Sentiment is at major extremes toward all things shiny.

Anglogold - AU - Options for November expiry are at 10,000 Calls vs. 6,000 Puts - a 166% rate.  Over 35% higher than the market average.  Anglogold is trading at almost 5 times its book value, after having negative operating cashflow in the last quarter, and has only 1% short interest.  Again, extremely overdrawn sentiment driven entirely by hope for a massive continued run-up in gold's recent superman-esque run.

Current price inclinations on gold are the result of speculation only and are not fueled by real market fundamentals - credit levels have contracted in the US relative to the levels at the previous high in gold set in March 2008, debunking the Hyperinflationists philosophy.  The US dollar is not nearly at its low point of March 08, whereas gold is at a higher high almost inverse to the comparative difference in the USD from its previous Index price.  See here:



A major non-confirmation in what so many people see as the unflinching connection - that as the USD drops in value, gold goes up - shows us that the last legs of this rally have been driven by sentiment only and have no reflection of real fundamental aspects.

The "flee dollars" panic is so strong, and the "gold to $5,000" crowd getting so big, that any day now we could witness a drastic and sharp reversal that could wipe out these new record prices in gold in one or two trading days.



In the end, most glitter-loyal gold bugs, I recommend selling those mining stocks and closing out any open futures contracts on the shiny metals you might be exposed to.  Gold is about to get a heck of a lot cheaper.

For this, you should be celebrating.  Since your loyalty is undying no matter the economic environment, the opportunity to buy so much more precious metals with those worthless FRN's (Federal Reserve Notes, for those non goldbug-ese speaking readers) should be an occasion for joy and laughter.  Throw pride and unfounded claims to the wind for a moment and seize what may well become the last good buying opportunity for gold and silver as the final corrective wave of this depression takes them down to levels we can really call "cheap".

Our recommendations have not changed, meanwhile, for the broader markets - consider this lengthened (and fast waning) rally in the broad markets as a generous gift from Mr. Market.  You have the opportunity to cash out 50% richer than you were last March, and avoid the massive losses that those who are chasing "break even" are soon to incur.  Hold cash or the safest short-term equivalents and be ready to pounce on a highly depressed and pessimistic market in virtually every asset class under the sun. 

For the more aggressive investor and trader, now is the time to set up fantastic short opportunities in the broad market and the weakest/most overvalued companies. 

As always, be careful out there and watch yourself!

Derek.



Full Disclosure:  While I own precious metals from years of accumulation, and generally favor silver much more than gold, I have not purchased any physical metals for almost 12 months, and do not plan to until a major correction in dollar terms (est. <$8/oz for silver) has occurred.  I own LEAPS on almost all of the major US banks, several commercial real estate companies, and Barrick Gold.  I also have transferred over 50% of my portfolio in cash form into short-term US treasury bills.

Remember, Investophoria.com is the opinions and trading activity of the author only.  Any investment decisions you make are your sole responsibility.

Wednesday, October 21, 2009

A Closer Look at the USD Reveals That the Decline in the Index is Almost Done

A quick post today, to follow up on yesterday's article.

We certainly believe that the stock market is at or nearing an imminent turn towards a rapid crash in prices.  Against that movement, we have the USD, which should perform at least as well as it did through the end of last year as equities around the world collapsed in price.

The Daily Sentiment Reading on the USD is holding at 4% bears, and has been at or below this level for over 3 weeks now.  I cannot recall ever seeing a highly negative reading stay so dire for so long.  This shows that there is almost no one left on the long side of the trade - similar to the type of reading we saw on the S&P500 through March of this year, just before the market turned and started its most breathtaking rally in almost 3/4 of a century!

Open interest on the EUR/USD has been setting record after record, showing that the last legs of this rally have been purely speculative, most likely investment banks using that well-earned TARP money to try to squeeze out some more profits.  The open interest move from July to August alone was from 244,666 (a record for all time) to 271,410 (a much higher record for all time!).

Even just by looking at a chart we see the same sort of waning true strength with some simple indicators.

Notice that, just as in Nov-March where the USD made a new high, the price itself might be moving up, but the strength of those price movements is dying fast.
As usual, we recommend taking the contrarian approach - selling stocks, just when the media thinks that everything has been effectively papered over by the government and the "worst is over", and buying the dollar, at a time when a fellow like Robert Kiyosaki is saying "it is trash" and that we should all be buying precious metals.

That's right, folks.  Robert Kiyosaki - the fellow who was telling you to buy maximum leveraged real estate is now telling you to dump the dollar for gold and silver.  Smells like a great mid-term top-picker to me.  The "gurus" all tend to be right just enough for everyone to think they are gurus, then are proven wrong.

To conclude, we are forecasting a rise in the USD index to above the 95 level, coupled with a significant (probably more so in percentage terms than the last one) decline in stocks.  Our recommendation continues to be to liquidate stocks and risky bonds as soon as possible, and hold cash and short term treasury bills that can be sold quickly for the time to buy stocks and other assets.  For the more daring investor, finding several weak sectors of the economy (especially in deflationary times) and short-selling the shares or buying LEAPS against the weakest companies is recommended.



Full Disclosure:  While I own precious metals from years of accumulation, and generally favour silver much more than gold, I have not purchased any physical metals for almost 12 months, and do not plan to until a major correction in dollar terms (est. <$8/oz for silver) has occurred.  I own LEAPS on almost all of the major US banks, several commercial real estate companies, and Barrick Gold.  I also have transferred over 50% of my portfolio in cash form into short-term US treasury bills.

Remember, Investophoria.com is the opinions and trading activity of the author only.  Any investment decisions you make are your sole responsibility.



Monday, October 19, 2009

A Major Non-Confirmation for Stocks and Gold that Should Give You Pause

As the US markets doggedly continue their upward tread, a few points need to be clarified.  I have had several readers email me regarding my recommendation to sell out of stocks and take long-term short positions as of late August.  Those readers argued that the market has gone up for almost 8 more weeks since then, and that my recommendation missed a significant rally.

At first guess, that might sound true.  However, as I demonstrate on this chart, while readers might feel like the market has gone up drastically since my sell recommendation, it has in fact only gone up about 7%.







The reason it feels like so much more is exactly the reason that you should consider selling your stocks if you haven't already - the news has been hyping the higher-high situation, economists are out of the woodwork with raised GDP projections and analysts are raising price and earnings targets across the board on public companies.

However, despite the obvious improvement in sentiment, over 80% of the market's improvement in the way that counts (dollars and cents) was fully completed at the time of my recommendation.  That isn't to say that the market could make another higher high, maybe even two.  What I am saying is that the odds of a violent decline in stock prices only go up with each up-tick in this market.  Sentiment is too wildly positive on stocks and the economy, as I have covered in previous articles.  It is also far too wildly positive on gold.

Consider the following:


Gold has made an all-time high, and broken over the important psychological barrier on a weekly close for its first time in history.

However, when priced in a basket of other major currencies, one can see that gold is not actually making new highs relative to its March '08 historic launch.

In fact, this is almost a picture perfect example of an A-B-C correction formation when priced in a currency basket.  Wave B would be at or very near its peak, and wave C should carry the price of gold down below the low set last October.




The other  worrisome aspect of this high in gold is the fact that, despite being historically consistent in so many eras, this new high has not been confirmed by silver, even when priced in USD's.  This illustrates a far-too-positive sentiment level on gold that must correct.  Remember, as I said in my much-hated article in September, the time to buy gold is when everybody hates it - ETF inflows are setting records, Chinese governments are posting advertisements to citizens on buying gold (honestly, when has government EVER been good at timing a market?), physical investment demand is at a peak, and prices are at all time highs despite the fact that production is increasing and overall market demand is down.

I am forecasting a serious multi-month decline in precious metals, led by a reversal in over-extended sentiment and a bottoming and multi-month incline in the US Dollar as deflation rears its head.  We should see precious metals at new 2-year lows, if not 3-year lows.  This will most likely be the last good buying opportunity for these purchasing-power-retaining assets as a multi-year bull market ensues and takes them somewhere close to the "gold bug" high's in price.

As for stocks, I retain my advice.  Get out of your long positions, hold cash and short-term safe bonds that can be rolled over easily.  Be prepared for a buying opportunity few people ever get to see in their lifetimes within the next 5 years.

I'm excited... Are you?

Be Safe and Smart out there, Folks!

Derek.

Wednesday, October 14, 2009

The Spec Trend is Still Intact!

Back on September 14th, Investophoria forecast the following:

"...this is what we can expect over the short term"

 One month later, here is where we stand:

Bullish sentiment on the Major US indices is still well over 90% according to the Daily Sentiment Index (Trade-Futures.com).




Gold has smashed through the $1000 / oz barrier and has been making so many new all-time highs that reporters are just copy-pasting their previous articles and changing the timestamp.  Overnight trading last night saw the metal just shy of the $1070 mark.  RSI is extremely overextended, and roughly 50% of the current gold futures market is in speculative (non-commercial) net-long positions.  Sentiment on gold is also in the hyper-extension range.

The dollar has continued to lose ground, making an 12-month low.  Sentiment against the dollar is 90% bearish.

Speculative investments are on the rise, as a return to the 2007 mentality of IPO's and Corporate merger/buyouts being the major driver of the economy

I don't know about you guys, but I have at least one conversation per day with someone who tells me how much money they made on Bank of America or Citigroup and that I should be buying.  To say that they look at me like some fuzzy alien when I tell them I am 80% cash and 20% LEAPS is a huge understatement.

Commodities seem to have become the new real estate.  Do you know anyone who would dare say that commodities are a bad investment right now?  They are few and far between.  Even those who were right about the first leg of deleveraging and asset losses are proclaiming themselves bullish on all things that hurt when you drop them on your foot.  While I am long term bullish on commodities, many of them are going to suffer a very serious setback mid-term.

Bond yields are exactly where they were on Sept 14, currently trading at 340 basis points for the 10 year.  But hey, seven out of eight ain't bad!

And now to the meat and bones of the deal.  Where are we headed from here?

From a pure probability side of things, every day that this rally runs up higher and higher, the odds of a major shift in long-term sentiment are growing.  Sentiment levels are at the same heights as during the market top in 2007.  This is the most dangerous environment to be long almost anything that I have seen in a very long time.

But.  The trend is still rockin' along!

The various news outlets and market pundits are all calling for Dow 10,000.  Funny enough, even though the market gapped up to 9977 this morning, I am not sure if we will make it there.  Everyone has their eyes keenly set on this target, and often times such a speculative rally exhausts itself just prior to the obvious and most-sought price targets.

Then again, I could be wrong.  In then end, it comes down to this.  I cannot say with 100% certainty where this market is headed.

However, I can say with 100% conviction that the odds are highly stacked and piling on for a Wave 3 decline to start any time now.  And I can say with 100% conviction that I am sleeping soundly knowing my longs are closed out and I am ready not only to profit from the decline but to be waiting at the bottom, cash in hand, for the no-holds-barred fire sale.

I wonder how many other buyers will be there with me?

Stay safe.

Derek.

Thursday, October 1, 2009

Against the Tide

The last 10 trading days have been interesting ones.  We've had calls from "top economists" (who were as clueless before as they are today, I might add) for the end of the recession and the start of a long, arduous, recovery.  Echoes of weeks gone by.

Clamors are heard from all interested parties that real estate has finally bottomed.  The Case-Shiller Home Price index has inched up for the last 7 months straight.  Pending home sales are at their highest level in recent memory. 

Despite these calls we have seen higher unemployment, worse industrial performance, and auto sales further into the abyss.

Sentiment is beginning to turn.  RSI has swung violently down as this rally has petered out, showing the weakness of its latter stages.  Meanwhile speculation is ongoing as IPO's and Corporate Takeovers are at or above levels seen at the top of the market in 2007.  Fund managers are shuffling around toxic assets and worthless stocks like its a trillion-dollar game of hot potato! 

The tide is still up, to this point.  As I have said in earlier posts, we could see one final manic, bipolar-euphoric push to new heights.  The technicals are screaming that there is one last chance for this rally and it is right on or about 9450 for the DOW.
















We are within a few points of this marker.  It can be said with almost 100% certainty that while retail investors of most walks are seeing this latest dip as a buying opportunity, a broken trend-line is the mid-term harbinger of doom for the US markets.

As always, we are sure Mr. Market has a few tricks up his sleeve and would not be very shocked if there is a last manic rush.  At this point of the game, however, the odds aren't looking so good for the many longs out there.

We re-iterate that, although we offer recommendations only - and that your money is your responsibility and yours alone - if you are not an experienced trader, you sit in cash and ride out the next wave down.  If you are familiar with short-selling there are many opportunities to be has as the latest portion of the rally revealed just how speculative its nature was.  Many companies either owned by the government or having negative equity values saw 300% and more increases in share prices.

The market will surely surprise us, but with some of the last great market bears weakly donning the bull suit of late, it seems there are very few left on our side of the aisle.  We dropped the bullish suit a month ago and quietly donned the grizzly garb when everyone was running for their horns and hooves.

That Mr. Market, the maestro, waved his red flag and they all came running.  

Sentiment will continue to plunge as people are caught trying to make up losses incurred last year, and find they are in a second bull-trap and doubling down on the pain.  We should see the VIX near its highs set last winter, if not higher.

Don't be one of the many.  Guts, brains, and an iron resolve will make a few very wealthy in this market.  Be one of the few.

Don't chase the trend.  Start the trend.

Derek.

Thursday, September 24, 2009

A Lesson In Futility (And why "cause and effect" will lose you money)

Another Thursday in market land.  The Asian markets (excluding Japan) overnight were hammered.  Currently the Dow is sitting at -44 points. Gold has dumped back down below the $1000 / oz mark to $998.

At 10:30 this morning I clicked over to Google Finance's home page and came across something pretty hilarious:

Two headlines, one after the other.



 

This goes back to the same thing I have been saying for some time now.  Newswires are probably the least helpful resource for figuring out market activity.  Traditional reporting tries to push fundamental data onto market behavior - this only works some of the time.  The even worse part is that no matter which way they spin the movement-to-data correlation, to the average reader is sucked in because they make it sound plausible.

This is why technical analysis is so very important.  Realizing that the markets are just a massive collective of people trying to assign subjective value to various assets makes you realize that fundamentals are very slightly involved.

In fact, I think it is more viable that the OPPOSITE correlation/causation effect can be applied to markets.  It is more likely that the overall psychology and mood of the markets are what drive fundamentals. 

I know that is a bold statement.  However, look at a few recent examples in history to see what I mean.

The Dot-Com Buble

During the wild upswing in earnings-less company share prices in the late nineties, where were the fundamentals?  Nobody cared about the true equity of shareholders, the actions of management, prospects for future revenue, even dividends!

In fact, it was significantly after the market topped out and crashed that these companies started going bust.  In the year following the market top, another 200+ companies entered the market and successfully IPO'd their stocks to the general public.  It wasn't until much of the market losses were realized that people remembered dividends and real products and services.

A good example of this type of psychology is Enron - the stock started to decline months before any issues over the fundamental soundness of the company and the fraud of its earnings came up.  It is more likely arguable that it was the declining stock price that caused shareholders to become more fundamentally concerned - A constantly rising asset price causes complacency - nobody really cares while they are making money.  However, a declining stock price causes investors to ask "why" and start looking critically at the asset they are holding.  THAT is where the cracks actually start to show.


The Banking Sector and Subsequent Crash

The same sort of scenario applies to the financial sector during the housing boom.  When share prices were jet-packing it higher, nobody cared about what the banks were doing - nobody thought about their equity to exposure levels, the quality of loans they were issuing, the recycling of debt into securities, the appraising practices coupled with mortgage insurance.  Nobody cared.  In the words of Citigroup's then-CEO, Charles Prince, "We're Still Dancing".


But the market formed a top in late 2007.  After that point, during the steady decline, people started to question the fundamentals, they started to wonder just how much trouble these banks were really in.  When the picture became apparent, the market subsequently tanked. 

Many folks argue that the Merrill Lynch failure in 2009 was the cause of the market crash.  However, empirical evidence argues against that - Merrill crashed on Sept the 9.  The market actually rallied UP for a few days, held relatively flat for a week, then began a huge decline.

 


So, you ask yourself.  "What does this have to do with markets today?"

We are back to a similar type of mindset that existed at the 2007 market top.  A smaller group of stocks are advancing while the rest of the market is stagnant.  Currently, on some days, Bank of America, Citigroup, and AIG make up a HUGE portion of daily volume - this points to the more speculative nature of today's investors.  Speculation is a high-probability sign of top-forming activity.  Banks are repackaging mortgages again, even securitizing life insurance!  People don't care about the fundamentals at this point, they care about making back those losses from last year, wherever they can.

"If that means buying a stock with NEGATIVE common shareholder equity, then so be it!"

Keep that in mind when you are deciding whether to get into or out of the markets - many retail investors base their activity on these sorts of data, and this is only asking to have your money destroyed.  Someone else's interpretation of markets with a data correlation slapped on there is not going to help you in the least.  Do you own research, learn some technical analysis so you aren't left wondering "why did the market do that when that good announcement came out?".



As soon as the markets begin to turn again, the mood will shift toward underlying fundamentals yet again, and will turn negative once people start paying attention.  This is the point where the next and largest leg down in the market will take place.

The economy is in worse shape than it was at the market bottom - if the market ALWAYS traded on fundamentals it would be much lower.  However the market doesn't work on that basis.  It's people and money and all of their dreams and desires and greed and fear. 

There's a little too much greed in the air and not enough fear for me to suggest being long any stock right now.

Stay sharp out there!

Derek.



Friday, September 18, 2009

A Late-Summer-Week's Waiting

What a week!  Or should I say, "I was napping - what did I miss?"

The answer is not much.

Sure, the S&P 500 and Down logged a 2% + gain for the week.  Sure, gold held above the fabled $1000.00/oz mark.  It currently sits at $1006.50

But these are all things that we at Investophoria expected.  This is the last hurrah, the final call for all the new bulls to pile on board.  The smart money started walking away some time ago and now this rally is left to the speculators and those who "hope".

Insiders had huge net outflows over the last 6 weeks.  The largest on record for some time - these folks who know far more about the state of their company's affairs than we ever could.  They were net sellers to the umpteenth degree!  For the month of august, insiders sold something like $36.00 worth of shares for every $1.00 they bought.

Doesn't sound like those in the know are feeling to rosy, does it?  That's about 18 times the average inflow to outflow for insiders!

It does get better though.

Another little tidbit to remind all readers that the bubble days are back:

"IPOs return.  8 Companies want to raise $3.7 Billion"

That's right - 8 Initial Public Offerings in a single week!  That is more in a single week than was average during the absolute top in the markets (the average was about 5 per week)What's more, there are now 89 companies in the IPO process.  Back in March, at the market low, there were only 29.

IPOs are a sign of timing - as in they prey on over-heightened sentiment.  The more IPOs out there, historically, the worse the timing is.  Remember the tech-bubble era?  The mania is back, folks.  Which means the hangover is most likely not far behind.


As usual, a picture says a thousand words.

This should raise a few red flags for anyone long out there.  Our strategy remains the same - we expect a very large and ongoing plunge in all asset prices across the board.  Housing, Stocks, Commodities, Warrants, Gold and Silver, Junk Bonds, etc.

Cash is king. Right now.  Or it's nearest cash equivilants - namely short term treasury bills.

We expect the market to turn within the next 30 days, and begin the larger and more violent of the declines as realism sets into sentiment.  The opportunity to buy will be sooner than we think (we think).  But it is most certainly not now.

I'm going to leave you folks with a story.  A short story, but one well worth paying attention to.

One of the clients I invest for had a meeting with the banker that handles his main business affairs early this week.  This banker has been in the industry for many years.  He's the type of banker who only handles the "important" clients.  Let's call my client Andy.

During their meeting, my name happens to come up.  "So, Andy , how are things going with Derek?  Has he made you any money in the last year?"

Andy smiles.  "Yes.  We are up 48% since last September".

The banker at first thinks Andy is lying.  When he finally realizes he is not, he leans in.  "How did he make 50% in the last year?  Everyone I know lost his a huge amount!  Even I lost 25%!"

Andy shrugs.  He knows my investment strategy and "contrarianism" as well as he can with my few explanations.  But how do you put that into a few sentences.  He can't.

"Well," says the banker, "what's he invested in?"

Andy smiles again.  "Actually he's just moved me into about 85% cash."

The banker does a double take.  "Cash!?  Everyone I know is getting into the markets right now - it's the only place to make money!"

Andy shrugs again.  "I trust his judgment," is all he says.

I met with Andy a few days later for lunch, to go over our game plan in the coming months.  He relayed the story to me.  At the banker's last line, I just had to laugh.

"That, Andy," I said.  "Is exactly the point."

Being a contrarian is not an easy life.  Everyone you know will surely think you are crazy at some point or another, or wave off your opinions as nonsense.  One must learn to have nerves of steel - to keep that emotion in check, because just as the market is psychology, so are your day-to-day interactions. 

It's fine to listen to what other people have to say, but remember to do your own research, form your own opinions and conclusions.  The results you see before your own eyes have not gone through another human filter.


Stay true the course, readers.  This story has many pages and plots to play out. 

Enjoy your weekend!

Derek.


Monday, September 14, 2009

Why I Just Shorted AIG


I've been looking for an opportunity to put to work our New Leading Indicator (or - should I say - potential indicator. That's what that “putting to work” phrase is about.)

In markets, you can paper trade and speculate “out of the game” all you want. That's great for the first short stint, but the real learning comes from rolling up your sleeves and getting dirty. Having to live through those first few times (and probably many to follow) of bi-polarism that the market so naturally induces in all humans. Of nail-biting excitement as your buys rally up, up and away! Or that gut-wrenching feeling as you watch those hard-earned dollars burn out with every down-tick.

But that is where the real learning happens.



Any theory is great (in theory) if proven using past data. Any idea can be justified, any concept empirically “proven” (just look at how our government puts out its statistics, and what their REAL counterparts actually look like).


It's putting them to work that tests their mettle. Most theories fizzle out pretty quickly – the flaws become apparent sometimes on the first attempt. Those that don't fade often require radical change.
And then there's the bigger point.


The market is a different beast than most places where theories are tested.  The market is not a controlled lab - there are no rewrites or backup prototypes.  If you flub the idea that money is gone, those moments or market action are gone.  Sometimes licking your wounds is the most learning experience of them all.  In markets all you have is the now, which quickly becomes the past-to-be-studied.


To truly test a market theory, you do it in real time. You do it so you have to fight away the emotions, actually pick stop-outs and targets and actually USE them. You do it to see if this idea gets framed and stamped above the mantle, or if it gets tossed to the flames below.


Which is where we come to now. Test numero uno. And, I suppose, where the title of this article gets its genes from.


Here's the skinny:




Ahh, yes,” you say.


Our New Leading Indicator (I have yet to come up with a name for it – the combination of price action, RSI action, and MFI to find potential reversals ahead of time – any suggestions fire them my way!). 

It has indicated (no pun intended!) a higher probability of smart money entering into a long position during the huge plunge and consolidated price action. This was followed by a sharp rally to over $55.00 per share.


Before that point the money started flowing out of AIG, potentially indicating the smart money winding down long positions and switching to short positions. Now we have a semi-down-trend starting to form and a slowly and surely decreasing MFI along with it.


It would seem that the optimal exit point for this trade would be when the MFI hits 20 or lower indicating a short-hammer on the stock. Kind of like last time it did this.  Not to mention this is all under the backdrop of a very bullish short-term market.


I am not going to get too technical about all of this, because this is a conjecture and a first trade, and instead of actually short selling the stock itself, I opted to buy $40.00 November Puts for $9.50 / pop x 2 contracts (a sample, so to speak).


If we DO see a re-occurrence of the price retracement as we saw in AIG in mid-July, there is the potential for at least 100% returns on these Puts.


I am not expecting to make a new low here – as you can see I have drawn a trend line to pick a rough exit point. I will close out my trade on two possible conditions:






  • MFI is greater than 20 but the price is at or below the trend line intraday.





  • MFI is 20 or lower but the price is still above the trendline.
Since the volatility on this stock is huge and 60 days is a long time in terms of AIG trader activity, I will set a stop out on the following condition:




  • The price of AIG closes higher than the intraday high set in late August. I will sell the Puts for whatever they are worth on the following trading day.






We'll see over the coming few weeks whether our New Leading Indicator is off to the races or flops down dead.


Derek.

Full Disclosure:  Wouldn't You Know it, I'm Short AIG!